Unless you’re lucky enough to do business with blue chip companies and public bodies, you’ll need to try to ensure that your customers will be able to pay your invoices. Here are the key things you need to know about checking credit ratings.
Why is it important to check a customer’s credit rating?
Imagine walking into a supermarket or store that you’ve never used before, and filling a trolley full of shopping. That’s not so unusual, but also imagine that you’re not asked to pay at this point, but simply required to promise you will pay and to provide proof of your address so that a bill can be sent later. You do this and walk out with your selection.
This sounds far-fetched but many smaller businesses who provide goods or services to other businesses, which are invoiced at a later date, do pretty much the same thing and then seem surprised when some customers don’t pay.
Providing goods or services in advance of payment gives you access to more potential customers, but it also exposes you to the risk of customers defaulting. To reduce this risk you need a system for credit checking customers.
What’s the first step in checking a customer’s credit rating?
Ask your new customers to complete a credit application form. This will give you the information you need to assess their credit risk, and will also show them that you take a serious approach to granting credit. The credit application form should include:
- Full name of the business and any names it trades under.
- The name/s of the business owner/s.
- The name and contact details of the person who’s responsible for arranging payment and for dealing with any queries.
- The registration number of the business if it’s a company.
- The amount of credit being requested.
- Requests for consent to approach the following:
- a credit reference agency
- their bank (for a reference)
- at least two trade references (e.g. existing suppliers).
Generally speaking, the larger amount of credit a customer asks for, the more checks you need to do.
What help can credit reference agencies give?
In the same way that credit reference agencies can check personal credit ratings, they can check out a business’s likely ability to pay back debt.
Credit reference agencies work with building societies, banks, mobile phone companies and other major retailers. When a person or business applies for credit they will use any data stored against this person’s name and address to decide if he or she will be likely to pay it back. It is then down to the lender to decide whether to give credit or not.
The are three main credit reference agencies in the UK: Callcredit, Equifax and Experian.
Credit checks and results
Credit checks
Credit reference agencies investigate factors such as whether the customer pays their bills on time, whether they have any county court judgments against them, and what their financial results are.
A business credit report will provide a comprehensive financial view of the business.
Reports can be obtained on limited, non-limited, sole trader and PLC companies.
Credit checks can be carried out online and reports will be available to view within minutes of requesting. A search is straightforward – all you will need to enter the company name and/or registration number along with town/city and/or postcode into the relevant fields. A Directors report can cost from £5.99, a full company report from £13.99 (Experian prices).
More information can be found on the following websites:
Equifax Business Credit Reports
Credit check results
Agencies will provide a credit score which shows their view on the customer’s credit risk. Agencies can deliver instant reports online as well as carrying out more detailed investigations.
A business overview will typically include:
- basic business information
- credit risk and rating
- payment history
- number of county court judgements.
Reports can also include:
- Director details
- financial accounts for the past five years (profit and loss, cash flow etc)
- analyst comments.
What information can I get from the potential customer’s bank?
Write to the potential customer’s bank and let them know what credit amount and payment terms you’re thinking of offering their client. Ask the bank if:
- in their professional opinion, their client will be able to meet the conditions you’re thinking of offering
- they’re aware of any actions for the recovery of debt relating to their client.
Bank references typically cost about £25. It can take some time to receive them.
Checklist: How do I get trade references for a potential customer?
Send an email or letter to the trade referees provided by your potential customer, asking them the following questions. Login to save this checklist to your profile for future use – as you work through the list, any checkboxes that are ticked or unticked will be automatically saved to your profile. (To register to join and enjoy the benefits of membership click on the link at the top right of the page. It will only take a few minutes to create your profile).
You must be logged in to use this checklist
How else can I assess a potential customer’s credit risk?
If your customer is a limited company you can ask them for their latest accounts, or you can request them yourself from Companies House for just a few pounds. But be aware that the accounts may be over a year old.
If it’s practical to do so, why not visit the potential customer in person? This may give you a perspective of the customer that you might not get from credit checking agencies and banks.
How should I set credit limits?
Once you’ve done your research and considered the information you’ve received from credit agencies, trade referees, banks, etc, you need to make a decision about whether to give the customer credit, and if so, how much.
The upper credit limit you set for a customer should be the amount you’re willing to lose if things go wrong, e.g. the customer becomes bankrupt or insolvent.
If a customer says they want to purchase goods or services from you that would take them over the limit you’ve set, you can try to ask for payment up-front for the extra amount.
You may wish to make use of a system of ‘risk codes’ to help with your decision:
- A (low risk) – applied to those with the best credit referennce and payment records
- B (average)
- C (high risk) – slow payers, those with county court judgements (CCJs)
- N (new) – new customers you have only traded with for a few months.
For more on reviewing credit limits read an article by Experian here.
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